What's Behind Liquidnet's Acquisition of Vega-Chi

Liquidnet announced its expansion into the fixed income market with the acquisition of bond trading platform Vega-Chi buy-side firms look for alternatives to the current corporate-bond market structure which relies on dealer liquidity.

The deal, pending regulatory approval, positions Liquidnet, the global institutional trading network for equities, to enter the corporate bond market through its institutional customer base and with Vega-Chi’s technology.

“We’re not taking our equity platform and converting it to a fixed income platform,” said Seth Merrin, Liquident’s CEO, in an interview. Liquidnet will rely upon Vega Chi’s bond platform while leveraging its relationships, distribution, reputation and track record to build out the largest institutional size liquidity pool for corporate bonds, said Merrin. Liquidnet will draw upon its network of 740 asset managers around the globe as well as its relationships with many exchanges and brokers around the globe to grow Vega-Chi’s corporate bond liquidity pool.

Currently, Vega-Chi operates a corporate bond -trading platform for all market participants that trade U.S. high yield, European high yield and European convertible bonds. Liquidnet and Vega-Chi expect to launch an investment-grade corporate bond platform for the U.S. and Europe in 2014. Initially Vega Chi’s trading platform will continue to operate separately from Liquidnet’s core equities business, according to the release.

The move is another sign that consolidation is coming to the electronic bond trading space. “The Liquidnet acquisition of Vega-Chi is a first sign that a successful equity market operator is entering the fixed income marketplace which will help to further drive innovation in our industry. It is also a show of clear progression towards established players entering the space in order to help fend off a future liquidity crisis from rising interest rates,”commented Michael Chuang, CEO and founder of iTB Holdings, an aggregator of fixed income platforms. Two weeks ago, London Stock Exchange’s MTS unit agreed to acquire Bonds.com, an electronic trading platform for corporate and emerging fixed income.

Liquidnet is acquiring Vega-Chi at a time when the corporate bond market has been going through a liquidity shortage as dealers have slashed their inventories by more than 70 percent since 2007.

While the primary market for new issuance of corporate bonds in 2013 was more than five times the size in 2008, and the absolute market has more than doubled by as much as 170 percent between 2007 and 2010, “This is also the genesis of the problem,” said Merrrin “You have an asset class that has expanded massively in size, but at the same time, the infrastructure has not kept up and capital and liquidity provided by the market makers has collapsed,” he said.

Merrin said that Liquidnet’s clients have “massive portfolios and the liquidity that the dealers are willing to provide are a fraction of what it used to be. This is a mismatch,” he said, noting this will get more challenging as the Fed raises interest rates and buyers then look to sell.

To fix the liquidity drought, it’s important for market participants to come together and establish new systems and processes and an open platform that will facilitate the flow of liquidity in the corporate bond market more efficiently, stated Merrin.

In the interview, Merrin said, “Constantino’s team has recognized the sort of impending doomsday scenario that is coming down the pike with the lack of liquidity in the market and the lack of dealer capital and they built a very robust platform and they have a great team. “We need their platform and expertise and team, while they need their liquidity. Together they’re going to be available as part of the corporate bond trading infrastructure,” said Merrin

A Market Ripe for Change

A recent report issued by Tabb Group, more than three-quarters of the buy-side firms told Tabb that now is the time for an alternative trading system to emerge to bring increased transparency and support for the liquidity-constrained corporate bond market.

“We offer a very different product,” said Constantinos Antoniades, founder and CEO, Vega-Ch,i in the interview. Some of the other existing players – MarketAxess, Tradeweb and Bloomberg, offer request-for-quote, which is a dealer to client protocol, he noted. “We’re offering an open, “all-to-all order book where every participant, buy-side to sell side can post liquidity and exchange liquidity,” he said.

Similar to the way that Liquidnet saw a way to help the buy-side trader source liquidity by trading large blocks electronically with each other, Vega-Chi distinguishes between small trades and block trades in the corporate bond market.

There are two parts of Vega-Chi’s model – the normal order book for orders of $1 .2 million to $5 million and for block trading activity, orders over $5 million, explained Antoniades. The normal order book is available to everyone. In the block trading facility, the user gets to specify what should be the minimum contra side and the size of their order that is visible to someone. “You can say the only contra orders must have $7 million in size or within 20 cents or half a point, otherwise no one gets to see them,” said Antoniades.

In what he calls the “conditional visibility order,” a concept that exists in Liquidnet for equities, a trader can set an order, which becomes visible only when someone meets their criteria. “That functionality has received positive feedback from clients in Europe and U.S.,” said Antoniades. “What we were missing was to get more visibility in some of the largest clients. That goes way overnight upon the heels of this transaction,” he added.

While some existing electronic fixed-income platforms are experimenting with new protocols to prompt the buy-side to provide liquidity, some are worried about what will happen when record low interest rates rise to their natural level. “When corporations want to sell bonds, there are buyers, but when those buyers in the secondary market want to sell, that is going to be the problem,” said Merrin.

When it comes to corporate bonds, "There is no 100 percent solution,” Merrin said. “What we do is exactly as we did on the equities side, which is to create an institutional pool of liquidity for bonds,” he said. “Clearly dealer facilitation is going to be a fraction of what it was, and they’re going to have to source liquidity as well. It’s going to come in and fill that void, so an RFQ systems are necessary and so is the natural pool of liquidity,” he said.

The acquisition will immediately boost Vega-Chi’s capital level, which has been an obstacle to landing larger asset managers as clients. Previously, Vega-Chi was a bit undercapitalized and large clients were not able to access them. But now that’s changed with the acquisition. “It’s all of our clients that have liquidity in the corporate bond marketplace,” said Merrin. Institutions are ready for a change in market structure and processes, suggests Merrin. “There’s been so much talk about it. We’ve never been asked to solve a bigger problem than in corporate bonds.”

Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio